Monday, November 17, 2014

Free Economic Zone “Crimea”: How to Pay Taxes?

Co-authored by Andrii Kuleba 
 (Junior Associate of 
Lavrynovych & Partners Law Firm)
Crimea is not ours anymore

The armed aggression of Russia has led to the annexation of the Autonomous Republic of Crimea in March 2014. Finally, in August 2014 the Verkhovna Rada (Parliament) managed to adopt the Act setting out rules for conducting business in the temporarily occupied territory of Crimea.

This is the Act of Ukraine “On the Creation of the Free Economic Zone “Crimea” and Specifics of Conducting Business in the Temporarily Occupied Territory of Ukraine” (hereinafter – the Act).

According to the Act the whole territory of the Autonomous Republic of Crimea, including the City of Sevastopol, becomes the free economic zone “Crimea” (hereinafter – the “FEZ “Crimea”).

The specific feature of the Act is that it establishes two different regimes of conducting business in Crimea. First one is actually the FEZ “Crimea” (Chapter I of the Act). Second one is the FEZ “Crimea” under temporary occupation (Chapter II of the Act).

What follows is a brief review of the tax treatment in respect of the FEZ “Crimea” under temporary occupation:

- Individuals and legal entities residing/located in the territory of the FEZ “Crimea” are equated to non-residents for the purposes of taxation (hereinafter – “persons equated to non-residents”).

- Ukrainian tax registration of persons equated to non-residents is cancelled. The FEZ “Crimea” source income of such persons is not liable to Ukrainian taxes and duties.

- Persons equated to non-residents may pay Ukrainian unified social contribution on a voluntary basis.

- FEZ “Crimea” source income of Ukrainian residents is treated as foreign source taxable income.

- Non-FEZ “Crimea” source income obtained by persons equated to non-residents in the territory of Ukraine is subject to Ukrainian withholding tax. Inasmuch as Ukraine does not recognize the annexation of Crimea, it is quite reasonable that the double tax treaty between Ukraine and Russia will not apply to this income.

- Transactions involving persons equated to non-residents (irrespective of whether the parties to them are related enterprises) are considered to be controlled transactions for the purposes of transfer pricing rules. Unfortunately, it is not clear from the Act whether such transactions are recognized as controlled automatically or only after reaching a value limit of UAH 50 million. At the moment, the State Fiscal Service of Ukraine sticks to an approach being favorable for the taxpayers. According to its position such transactions become controlled only after reaching the aforementioned value criterion (the letter of 6 November 2014).

- Goods supplied from the territory of FEZ “Crimea” to the other territory of Ukraine fall under the import regime with the payment of import duty, excise tax and VAT. However, such goods can be exempt from import duty where they are of Ukrainian origin confirmed by a certificate issued by Ukrainian chamber of commerce. The exemption at hand is confined to import duty only and does not apply to VAT and excise tax.

- Ukrainian goods from the other territory of Ukraine to be supplied to the FEZ “Crimea” fall under the export regime. According to the logic of the Tax Code of Ukraine, these goods must attract a zero rate of VAT. However, pursuant to an oral statement made by the leaders of the State Fiscal Service of Ukraine at a meeting with the members of the European Business Association held on 14 November 2014, there are no grounds for the application of the zero rate to such goods.

- Some tax incentives are made available to enterprises changing their location from the territory of the FEZ “Crimea” to the other territory of Ukraine. Such incentives, inter alia, include: (1) the cancelation of tax debts and the relief from sanctions for the failure to file tax returns since the beginning of the temporary occupation; (2) the exemption from import duty, VAT and excise tax for fixed assets and stock evacuated from the temporarily occupied territory; (3) possibility to deduct for the tax purposes an amount of documented expenses with respect to the evacuation of fixed assets and stock as well as to apply 100% depreciation charge with regard to the evacuated fixed assets.

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